An employer establishes an unfunded supplemental executive retirement plan (SERP) to restore the retirement income that key executives lose because of limits on qualified plan benefits.
Which statement best describes the SERP? Answer: The SERP may be limited to a select group of management or highly compensated employees, and the executive's benefit is an unsecured contractual claim against the employer's assets.
Under the nonqualified deferred-compensation rules (IRC § 409A) and ERISA's top-hat exemption, an unfunded SERP may be limited to a select group of management or highly compensated employees, and the executive's benefit is an unsecured contractual claim against the employer's assets. The statement that the SERP is subject to qualified-plan nondiscrimination testing and contribution limits misapplies § 401(k) rules, which do not govern top-hat arrangements. The statement that the employer's contributions are currently deductible misstates the deduction timing, which follows the executive's income inclusion. The statement that the SERP must be funded through an irrevocable trust to satisfy ERISA's minimum funding standards misstates ERISA, which imposes no funding or trust requirement on an unfunded top-hat SERP.
An employer establishes a nonqualified deferred compensation plan and funds it through a secular trust. Under the trust, the assets are held for the exclusive benefit of the executive and are not subject to the claims of the employer's creditors.
Which statement is correct regarding the tax treatment of this arrangement? Answer: The executive is currently taxable on the amounts contributed to the trust, and the employer may deduct the contributions in the year they are made.
A secular trust is a funded trust whose assets are not subject to the employer's creditors. Because the assets are held for the executive's exclusive benefit and are beyond the reach of creditors, the executive receives a current economic benefit, so the contributions are currently taxable to the executive and, under the deduction-matching rule of IRC § 404(a)(5), the employer deducts them in the same year. The statement that the executive is currently taxable but the employer may not deduct the contributions until the executive receives distributions is wrong because the deduction follows the executive's income inclusion, not the payout. The statement that the executive is taxed only when distributed ignores the current economic benefit of a secured, vested right. The statement that the employer is taxable on the trust's earnings confuses a secular trust with a rabbi trust; in a secular trust the executive, not the employer, is treated as the owner of the assets for tax purposes.
A corporation adopts an executive bonus plan under which it pays the annual premium on a life insurance policy owned by the executive, with the executive's designated beneficiaries named on the policy.
Which statement best describes the tax treatment of the premium payments? Answer: The premium payments are taxable to the executive as ordinary compensation in the year paid, and the corporation may deduct the premiums as compensation.
In an executive bonus (Section 162) plan, the employer pays premiums on a life insurance policy owned by the executive; the premiums are taxable compensation to the executive in the year paid, and the employer deducts them as compensation under § 162 because it is not a beneficiary. The option treating the premiums as nontaxable because the death benefit will be tax-free misapplies IRC § 101, which exempts only the death proceeds, not the premium payments. The option deferring tax until the death benefit is collected, and the option treating the premiums as a loan taxed on surrender, each misstate the current-compensation treatment of the premium.
A tax-exempt organization grants its executive a deferred compensation award. The award will be entirely forfeited if the executive leaves the organization before completing four years of service. At the end of the fourth year, the award vests and will be paid in equal annual installments over the five years following vesting.
When is the executive required to include the award in gross income? Answer: At the end of the fourth year, when the substantial risk of forfeiture lapses, on the present value of the benefit then vesting.
Under IRC § 457(f), amounts deferred under an ineligible deferred compensation plan of a tax-exempt or governmental employer are included in gross income when the substantial risk of forfeiture lapses. The four-year service condition is a substantial risk of forfeiture, so the executive is taxed at the end of the fourth year on the present value of the benefit then vesting. The option taxing the benefit annually as it accrues ignores the deferral during the forfeiture period. The option taxing ratably as installments are paid applies the general § 409A rule for unfunded plans of for-profit employers, not the § 457(f) rule. The option taxing only the employer's contributions excludes the investment earnings that are part of the present value taxed at vesting.
- Which of the following statements is true regarding an ineligible deferred compensation plan maintained by a tax-exempt employer for a highly compensated employee?
Answer: Deferred amounts become taxable when they are no longer subject to a substantial risk of forfeiture, even if payment has not yet begun.
IRC § 457(f) taxes an ineligible deferred compensation plan when the participant's right to the deferred amount ceases to be subject to a substantial risk of forfeiture, even if payment begins in a later year. The "taxable only when paid" statement describes an ordinary unfunded nonqualified plan, not a § 457(f) plan, which taxes at vesting. The bookkeeping-reserve statement is wrong because a tax-exempt employer pays no income tax, so it has no deduction to take at any time. A § 457(f) distribution is not an eligible rollover distribution to a traditional IRA.
A corporation establishes a nonqualified deferred compensation plan for its CEO and funds the obligation by transferring assets to an irrevocable trust. The CEO's right to the deferred benefit is nonforfeitable. The trust document provides that the trust assets remain subject to the claims of the corporation's general creditors in the event of insolvency. The plan complies with all applicable deferred compensation requirements.
For tax year 2026, which statement best describes the income tax treatment of this arrangement for the CEO? Answer: The CEO is not currently taxable on the deferred compensation until it is actually or constructively received, because the trust assets remain subject to the corporation's creditors and the CEO's right is unsecured.
Because the plan is compliant with IRC § 409A, rabbi-trust tax treatment rests on the economic benefit doctrine (Rev. Proc. 92-64): a transfer to a trust that remains subject to the employer's creditors confers no current economic benefit, so the CEO recognizes income only on actual or constructive receipt. The option that says the CEO is not currently taxable because the right is nonforfeitable and the trust is irrevocable reaches the right result for the wrong reason; deferral depends on the unsecured, creditor-exposed status of the CEO's claim, not on vesting or irrevocability. The option taxing the CEO on the trust's investment earnings misapplies the grantor-trust rule, which taxes the corporation as grantor, not the CEO. The option taxing the full present value because the funded transfer is a transfer of property for services ignores the creditor condition, which defeats a current economic benefit.
- Which of the following statements is true regarding an unfunded nonqualified deferred compensation plan maintained for a select group of management or highly compensated employees?
Answer: The plan is exempt from ERISA's participation, vesting, funding, and fiduciary requirements as a top-hat plan.
Under ERISA's top-hat exemption (ERISA §§ 201(2), 301(a)(3), and 401(a)(1)), an unfunded plan maintained primarily for a select group of management or highly compensated employees is exempt from participation, vesting, funding, and fiduciary rules. Nondiscrimination and minimum coverage testing apply to qualified plans, not to this unfunded nonqualified arrangement. A trust for the exclusive benefit of participants would make the plan funded and is not required. PBGC coverage applies to qualified defined benefit plans, not to unfunded nonqualified deferred compensation.
- Which of the following statements is true regarding an executive bonus plan in which the executive uses the bonus to purchase a life insurance policy?
Answer: The employer receives a current deduction; the executive currently includes the bonus in income; cash value growth is tax-deferred.
Under the current-compensation tax rules (IRC § 162), an executive bonus plan is a current compensation arrangement. The employer currently deducts the bonus, and the executive currently includes it in gross income; if the proceeds are used to buy cash value life insurance, the policy's inside buildup is tax-deferred. The deduction is not limited to the policy's cash surrender value because the bonus itself is the compensation. Nondiscrimination and coverage testing do not apply to this nonqualified arrangement. The executive is taxed on the bonus when received, not only when the policy is surrendered, matures, or is assigned.
An employer sponsors an unfunded nonqualified deferred compensation plan for a group of executives. In the current year, an executive elects to defer $50,000 of earned salary until a single lump-sum payment at retirement in five years. The executive has a nonforfeitable right to the deferred amount, and the plan complies with § 409A.
When is the employer entitled to a federal income tax deduction for the $50,000? Answer: In five years, because the employer's deduction for nonqualified deferred compensation is allowed only when the amount is includible in the executive's gross income.
Under IRC § 404(a)(5) and Treas. Reg. § 1.404(b)-1T, an employer deducts nonqualified deferred compensation in the taxable year in which the amount is includible in the employee's gross income. Because the executive will include the $50,000 in income at retirement when it is paid, the employer takes the deduction then. The current-year option at the deferral election ignores this statutory timing rule. The ratable option over the five-year deferral period has no statutory basis. The current-year option based on the plan being unfunded confuses funding status with deduction timing; unfunded status does not accelerate the employer's deduction.
A 51-year-old senior vice president of a privately held manufacturing company has already maximized her 401(k) salary deferral for the year. She tells her IAR about her employer's new nonqualified deferred compensation plan. She may elect by December 31 of this year to defer a portion of her bonus for next year; the deferred amount will be credited to an unfunded bookkeeping account and paid in a lump sum five years after her separation from service. The plan is offered only to the company's five most highly compensated executives, and no assets are set aside in trust.
Which of the following statements about the federal income tax treatment of the executive's participation in the plan is correct? Answer: The executive is not currently taxed because the election is made before the bonus is earned and the plan is only an unsecured promise; her deferred benefit is an unsecured claim against the company.
IRC § 409A and the constructive-receipt and economic-benefit doctrines govern an unfunded nonqualified deferred compensation plan. Because the deferral election is made before the year in which the bonus is earned and the plan is only the company's unsecured promise, the executive has no current income tax liability; if the employer becomes insolvent, her deferred benefit is an unsecured general creditor claim. The statement that she is not currently taxed but holds an unsecured claim is therefore correct. The statement that a trust protected from the company's creditors would preserve deferral is reversed: assets set aside beyond the employer's creditors' reach for the executive's benefit are an economic benefit that is currently taxable. The statement that qualified-plan nondiscrimination testing and contribution limits apply is wrong; avoiding those limits is a defining feature of nonqualified plans. The statement that a 10% early distribution penalty applies is wrong; the § 72(t) penalty applies to IRAs, qualified plans and § 403(b) plans, not to nonqualified deferred compensation.
An executive participates in her employer's nonqualified deferred compensation plan. In 2026, the executive completes the five-year service requirement that removes the plan's substantial risk of forfeiture. The vested balance will be paid in ten annual installments beginning at retirement in three years.
In what year are the deferred amounts taken into account as wages for FICA tax purposes? Answer: In 2026, when the risk of forfeiture lapses, on the amount then vested, before distributions begin.
IRC § 3121(v)(2) sets a special timing rule for FICA on nonqualified deferred compensation: an amount deferred is taken into account as wages at the later of when the services are performed or when the amount is no longer subject to a substantial risk of forfeiture. The services were performed over the five-year requirement, and the risk of forfeiture lapses in 2026, so the vested amount is taken into account for FICA in 2026, before any installment is paid. Taking the amounts into account at retirement when the first installment is paid, or ratably as the ten installments are paid, confuses FICA timing with income-tax timing, under which an unfunded plan's benefits are taxed when paid. Taking the amounts into account in each of the five service years ignores the later-of rule: while the amounts were still forfeitable, the lapse date, not the year the services were performed, controls.
- Which of the following statements regarding an unfunded nonqualified deferred compensation arrangement is true?
Answer: The executive is not taxed currently when the employer records the deferral, as long as the promise is unsecured and the amount is not paid or made available.
Under the constructive receipt doctrine and IRC § 404(a), an unfunded, unsecured promise to pay deferred compensation is not income to the executive merely because the employer records a bookkeeping liability, and the employer may not deduct the amount until it is includible in the executive's income. A bookkeeping entry alone is not constructive receipt, so the statement that the executive is taxed when the liability is recorded is wrong. The employer's deduction in the year services are performed is also wrong because the deduction is tied to the executive's income inclusion. Amounts in a rabbi trust do not become taxable when contributed because the trust assets remain subject to the claims of the employer's general creditors.
A client, age 50, is a senior executive in the 37% federal tax bracket. She has reached the annual limit on her § 401(k) contributions and is ineligible to contribute to a Roth IRA because her income exceeds the phase-out limits. She wants to reduce current taxable income further and expects to be in a lower tax bracket in retirement. She is comfortable with the credit risk of her employer, a highly rated company.
Which recommendation is most suitable for this client? Answer: A nonqualified deferred compensation plan permitting additional salary deferral beyond the § 401(k) limit, with deferred amounts taxed when distributed and subject to employer's creditors.
Nonqualified deferred compensation planning: the client has exhausted her § 401(k) limit, is ineligible for a Roth IRA, and wants to reduce current taxable income with retirement deferral at a lower expected bracket, so a nonqualified deferred compensation plan is the suitable vehicle: it permits additional salary deferral beyond the § 401(k) limit, is taxed at distribution, and carries a creditor risk she has accepted. The municipal bond fund provides tax-exempt interest but does not reduce her current salary or provide a deduction. The variable annuity defers earnings but offers no current deduction for contributions. The traditional IRA is not deductible at her income level because she is an active participant in a workplace retirement plan.
